Clients are usually pleasantly surprised by the answer—that special rules apply to figuring the tax on the sale of any inherited property. Instead of having to start with the decedent’s original purchase price to determine gain or loss, the law allows taxpayers to use the value at the date of the decedent’s death as a starting point (sometimes an alternate date is chosen). This often means that the selling price and the inherited basis of the property are practically identical, and there is little, if any, gain to report. In fact, the computation frequently results in a loss, particularly when it comes to real property on which large selling expenses (realtor commissions, etc.) must be paid. This rule is applicable to other inherited assets as well such as stocks.
This also highlights the importance of having a certified appraisal of the home to establish the home’s tax basis. If an estate tax return or probate is required, a certified appraisal will be completed as part of those processes. If not, one must be obtained to establish the basis. It is generally not acceptable just to refer to a real estate agent’s estimation of value or comparable sale prices if the IRS questions the date of death value. The few hundred dollars it may cost for a certified appraisal will be worth it if the IRS asks for proof of the basis.
For example, assume uncle Bill was a very smart person and he purchased a house in Los Angeles 50 years ago for $50,000. He passed away in 2014 and left the house to you. It had no mortgage or debt on it either. The fair market value of the house on the date of his death was $2,000,000. Assume you sell it sometime in 2014 for $2,000,000. After you pay selling expenses assume you net $1,900,000. The $1,900,000 is all tax free to you. And, its considered a long term asset. So if you sell it for more than the fair market value on the date of death, you pay long-term capital gains tax on the gain. The federal long term capital gain tax rate is 15% or 20%, it depends on your overall federal tax bracket.
Another issue is whether a loss on an inherited home is deductible. Normally, losses on the sale of personal use property such as one’s home are not deductible. However, unless the beneficiary, you, is living in the home, the home becomes investment property in the hands of the beneficiary, and a loss is deductible but subject to a $3,000 ($1,500 if married and filing separately) per year limitation for all capital losses with any unused losses carried forward to a future year.
In some cases, courts have allowed deductions for losses on an inherited home if the beneficiary also lives in the home. In order to deduct such a loss, a beneficiary must try to sell or rent the property immediately following the decedent’s death. In one case, where a beneficiary was also living in the house with the decedent at the time of death, loss on a sale was still deductible, when the heir moved out of the home within a “reasonable time” and immediately attempted to sell or rent it.
This treatment could change in the future, however. The President’s Fiscal Year 2016 Budget Proposal includes a proposal that would eliminate any step up in basis at the time of death and would require payment of capital gains tax on the increase in the value of the home at the time it is inherited.
The above technical reference is provided as a courtesy to the reader by David Silkman, CPA, MST, Broker, Silkman & Associates Accountancy Corporation and SilkRoad Realty, Inc. The information is technical in nature, may not include all the details on a particular subject and may require review of the reader’s circumstances by a professional. You should consult with your tax advisor.
David S. Silkman is a CPA, has a Masters in Taxation (MST) and is a licensed real estate broker. He specializes in real estate tax laws and accounting. If you have any questions, please do not hesitate to call him at 310.479.7020 x301, email him at david@saacpa.com or visit www.saacpa.com or www.SilkRoadRealtyInc.com. Thank you.
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